We all know how easy it is to get caught up in the excitement of house hunting. If you fall in love with a home before you have enough saved up for a down payment, you might be tempted to take from your 401(k). But there are serious downsides to borrowing from your 401(k) that could really cost you down the line.
Be realistic about how much home you can afford. If you need to borrow from your 401(k) in order to buy a home, there’s a good chance you can’t afford the house to begin with, which is the number one reason to avoid taking from your 401(k) for your down payment. If the potential for living beyond your financial means doesn’t turn you off, here are three more reasons taking from your 401(k) might not make the most financial sense.
1. Borrowing from your 401(k) can compromise your future wealth. Your 401(k) grows with interest over the years. If you borrow from your 401(k), that money would have potentially grown into a large amount in the next 20+ years prior to retirement. Plus, the money you would be using to pay yourself back would be the same money you should’ve been saving. Think of your 401(k) as sacred money to be used only for retirement.
2. You could be penalized for and taxed for early distributions. The IRS considers some situations okay to borrow from your 401(k) before you hit 59.5 years old. Unfortunately, a home purchase isn’t one of those situations. When you borrow from your 401(k), the amount is now considered taxable income so you incur a 10% additional penalty on the early distribution. And since your contributions are made with pre-tax money, when you go to repay the loan, your payback will be made with after-tax dollars meaning you’ll be double-taxed on that money.
3. Borrowing from your 401(k) can start a pattern. Once you’ve done something once, it’s much easier to do it again. People who live beyond their means continue to do so over the long term and people who are financially conservative also tend to stay that way.